A Fortnightly Newsletter
15th August 2011
Product Focus
Non Convertible Debentures

An NCD (Non Convertible debenture) is essentially a debt instrument with a fixed tenure that pays a certain rate of interest monthly, quarterly, annually or at the end of the tenure. The money invested is returned either over the tenure of the investment or at the end of the tenure (referred to as bullet payment). These are certificates issued by companies to raise funds through the public issue. These instruments cannot be converted into equity shares and usually carry higher interest rates than the convertible ones.

According to a circular issued by RBI NCD means:
  • Non-Convertible Debenture (NCD) means a debt instrument issued by a corporate (including NBFCs) with original or initial maturity up to one year and issued by way of private placement;
  • Corporate" means a company as defined in the Companies Act, 1956 (including NBFCs) and a corporation established by an act of any Legislature
In India NCDs shall not be issued for maturities of less than 90 days from the date of issue and NCDs may be issued in denominations with a minimum of Rs.5 lakh (face value) and in multiples of Rs.1 lakh. An eligible corporate intending to issue NCDs shall obtain credit rating for issuance of the NCDs from one of the rating agencies, viz., the Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd or such other agencies registered with Securities and Exchange Board of India (SEBI) or such other credit rating agencies as may be specified by the Reserve Bank of India from time to time, for the purpose.

Advantages of investing in NCDs
  • Better Returns: NCDs in the past have offered interest rates which were quite attractive as compared to interest on other fixed-income options. While yield on redemption of Tata Capital NCD issue was 11.57 -12%, effective yield of Shriram Transport NCD was in the range is in the range of 10.75-11.50% which compares favorably with term deposits (TD) of banks. India info line is offering interest rate of 11.7% per annum for all options, except the one meant for individual investors putting their money for five years, where the rate offered is higher at 11.9% per annum.

    If you happen to fall in the highest tax bracket (30.9%), your effective post tax returns will be 7.95 per cent based on rate of interest of 11.50% per annum. And if you're in the middle tax bracket (20.6%), return after tax will work out to be 9.13 per cent p.a. based on interest rate of 11.50% per annum. So, right now, NCD seems to be quite attractive investment option among debt instruments given that after-tax returns are around 8% for an investor in the highest tax bracket. However, in future companies might lower the yield based on the interest rate movement and debt market scenario.
  • No Tax deduction at source: Unlike bank FDs or corporate FDs, there is no tax deduction at source (TDS) on NCDs offered in DMAT mode and listed on a stock exchange as per section 193 of the IT Act. This, however, does not mean the investor does not need to pay any tax on the interest earned. Income tax on the interest income will have to paid at the time of declaring one's income.
  • Higher Safety: Unlike corporate FDs which are unsecured, NCD issues by NBFCs are secured debt (NCD's are 100% secured by assets of the company). Furthermore, both the NCD issues have received good credit rating. However, this doesn't guarantee 100% safety. Default risk still remains although very slight. But, default risk remains even in case of Bank FD's beyond Rs 1lakh.
  • Good Liquidity: NCDs offer good liquidity due to Stock Exchange listing (However listing does not guarantee liquidity). If you would like to go for premature exit, you can do it in two ways:-
    • Sell on the NSE
    • Exercise put option, if available.
However, remember that exiting through secondary market (NSE) entails interest rate risk. If the interest rates fall, the value of NCD will rise and in an environment of rising interest rates, the value of NCD's may fall below face value. But if you plan to hold it till maturity, then there is no-risk due to interest fluctuations.
Furthermore, there is also liquidity risk because Indian debt / bond markets are highly illiquid (less frequent trading and insufficient volumes). So, if you plan to sell NCDs before maturity by selling on the secondary market (NSE), remember that you might not be able to do so because of fewer buyers.

So we can say that for investors looking to park their money for long period, NCD is a good mode of investment, given that post-tax returns come to around 8% (for those who in the 30% tax bracket). Those in lower tax brackets can get even higher returns. Such instruments carry very low credit risk. Indeed, the NCDs have been rated 'LAA+' by ICRA, indicating high credit quality and low credit risk, and CARE AA+ by CARE, indicating high safety for timely servicing of debt obligations.

However, investors should also keep in mind that they may not get the right price on the NCD if they try and get out by selling it on the stock exchanges in the short term.
(1) Reserve Bank of India
(2) DNA
(3) Indian Express


What's the difference between NCDs & FDs?

Following are the differences between a NCD and a fixed deposit

Safety: While NCDs are secured debt, corporate FDs are altogether unsecured and bank FDs are secured to the extent of Rs one lakh only.

Taxation: There is difference in taxation aspect also. In addition to interest income, there can be capital gains if you sell the NCD before maturity. However, unlike FDs, there is no TDS in case of NCDs.

Interest rate risk: Unlike FDs, NCDs carry interest rate risk due to changes in market interest rates.

Why only NBFCs are issuing NCDs while manufacturing companies prefer issuing FDs?

Because some NBFCs are not allowed to issue fixed deposits, please note that the companies which are registered as 'non-deposit taking NBFCs' are not allowed to issue Public deposits / Fixed Deposits as per RBI guidelines.

Is DMAT account necessary for investing in NCDs?

Yes, a DEMAT account is necessary because all the recent issues of NCDs were compulsorily in the dematerialized form.

Is PAN also mandatory?

Yes, quoting PAN number in the NCD application form is compulsory irrespective of the amount involved as per SEBI guidelines

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